1% guideline exceptions?

Question

Hello everyone.

I am a new investor and have not done my first deal yet. I'm in the middle of reading the recommended books and going through "literally" all of the bigger pocket podcasts.

I understand the 1% guideline, 50% rule (guideline) etc, but what about in higher price markets and new/ newer construction?

If i were to purchase a new or newer home (only a few years old) to rent out, which you would expect to have very little capex involved, what numbers would you guys recommend using as a guideline.

I understand that many would say just look an hour in any direction for a lower priced market, but if you WERE wanting to stay in the higher price/ newer area, any thoughts?

Where i'm looking (south jordan, herriman, sandy, utah) i'm not finding any new/ new homes that come even close to the 1% guideline or 50% rule. (Could just be a possible indicator that prices are too high?) I'd "like" to start getting into some longterm holds while interest rates are still low, and before the fed raises more this year, but i also don't want to overpay.

Thanks in advance.

Andrew

Ned Carey · Answer

@Andrew Butler you can only decide that by running the numbers on a specific deal. The 1% (or 2%) rule or the 50% rule are all based on cash flow analysis. They don't take into consideration appreciation of property over time. Which can be your biggest return.

Some people can afford negative cash flow some people can not. Different investors have different needs and goals. You can only determine what is right for you by running the numbers on a specific deal and comparing it to your other investment choices.

You miss the point of cap ex. Brand new houses have theoretical capital expenses from day one. You just don't realize that capital expense until it comes out of your pocket.

Example

A water heater will cost you $600 installed. It will last 10 years. It is costing you $$60 a year. You don't see that expense until it pops up unannounced. It will not likely pop up on exactly the schedule you plan. The point is you need to be ready for those expenses.

Jacob Cogswell · Answer

Andrew Butler HOA are the deal killer look at more of the duplex or single family markets rather than the Townhouses. You can make them work, but your financial structure for the down has to be different than the normal 20-25% down you would want to do. Duplexes are the king for starting to invest. You buy them right, and they pay you every month, and the vacancy rate is a lot less because you have the two units. Start looking at those.

Russell Brazil · Answer

I find that the 50% rule is a good rule of thumb on a low rent property. So say a property rents for $600 a month. If you need to replace a toilet in that property and it costs you $150 to do so, that takes up 25% of that months rent. Even small repairs take up a huge percentage of rent.  But if a property rents for say $3,000 a month, that same repair should be relatively the same at $150. (Maybe it varies a little), but now that same repair is only 5% of the rent. So as you move up in rental price, the amount for repairs will become a decreasing percentage of the rent.

Now as that applies to capex, certain capex items will be relatively fixed or fall within a small range like a water heater in @Ned Carey's example.  But replacing a kitchen is going to have a much larger price variation.  On a $50k property you might be throwing in a $5k kitchen, but on a $500k property you might be throwing in $30k kitchen.  So the costs on a lot of capex will vary quite a bit.

But then with capex we are getting a lot into a few variables.  The water heater you might be replacing as soon as 8 years.  A roof isnt going to be replaced til 20 years and maybe 30 years. The HVAC system, not til at least 10 years, probably 15 and as high as 20 years out. So your planned holding period plays a huge role in this. BUT, hopefully you are getting rent growth in those 10 years which would make an exact analysis very very hard do.  I buy in strong rent growth areas, but I dont even pretend to come up with a number for how high the rent will grow. On many of my properties I can ballpark how much it will go up in value each year under normal conditions, but I cant even come close to projecting rent.

Also keep in mind RENTS CAN WEAKEN OVER TIME EVEN IN GOOD AREAS. I have a property where the rent unexpectedly weakened over time. This was due to new construction builds.  They increased the supply of housing, which in turn soaked up and weakened demand, and my rents went down.  Ive seen the same phenomenon happen to the price of a property in areas with a lot of new construction too. 10 years passes and the property hasnt gone up in value at all because the supply of housing continues to increase at a greater rate than demand.

Andrew Butler · Answer

Thank you all very much. @Rebecca Belnap and @Amy Kendall, you guys are awesome for your input and replies. I really appreciate the advice.

Rebecca Belnap · Answer

You are right, in South Jordan and nearby, it is very hard to come close to the 1% rule. @Sam Levin , @Amy Kendall, and @Jacob Cogswell are right, you will get much closer with multi-units.  Sam mentioned some off MLS new construction 4plexes in the Ranches par of Eagle Mountain that I've looked at.  Gross Rents are $5480 and the purchase price is $625,000.  Not a 1% rule purchase, but with new construction and a builder's warranty you should still cash flow nicely.  I worked out numbers on it for owner occupying with a 3.5% down FHA loan, where even if you pay full price and pay a property management company once you move out and have it fully rented it still cash flows $533 per month.  That includes an hoa, property management, everything.

The cost of your repairs really depends a lot more on who your tenant is than the age of the property.  A bad tenant can trash a brand new house and cause $10,000+ in damage.  I've had a tenant who have apologized for bothering me and asked that if I buy the new toilet, he would install it himself at no charge. (he was a contractor and wanted to know it was done right.)

Amy Kendall · Answer

I own a variety of investments from single families that are old, and new construction with HOA fees, I would, run analysis on each.  I own one new construction that has an HOA fee of $150/ month, that property cash flows about $200/ month after a 20% expense ratio (CAP EX).  I think HOA's have their place. If the numbers work on them.  That place has amenities I don't have on any other property (pool, clubhouse, gym, walking and biking trails, skate park).  There are all types of renters. Some people value those things other value a fenced in backyard with some privacy.  I like having a variety, I think it gives me a little diversity all in the same market. I also think as a new investor I would recommend getting into a duplex or triplex or fourplex, with an owner occupy.  You are going to get the lowest interest rate (investment properties tend to be about 1% higher than conventional 30yr), and lowest amount down. Just have to run your numbers. I also like the renovated or newer properties for the new investor, you then have a little time to save up your cap ex over time and not have the expenses right up front ;)

Andrew Butler · Answer

Awesome, thanks @Jacob Cogswell. I'll look into those. In our local areas do you see a market that can follow the 1% or 50% guidelines? Or do you just strictly look at the numbers on each deal and see if they cashflow after netting everything out?

Andrew Butler · Answer

Thank you @Ned Carey, @Jacob Cogswell, and @Russell Brazil for your replies and advice. I really appreciate it. It is nerve-racking and overwhelming trying to vet deals and decide where to even start looking.

I've glance at a few new developments where younger families are moving and renting, but they all have HOA of $200 plus which seems like would kill you profits when you get hit with periods with vacancies. And those would barely cashflow positive after the debt service (aka not adding to an account to account for vacancies and the capex). Perhaps that's just a bad place to even be considering starting.

My long term goal is not necessary cash flow, (at least in the next 5-10 years) but to build a portfolio that will sustain it's self. i.e. i'm not throwing cash into it every month (i'd also like a property manager for my properties eventually when i scale) so I need to account for that also.

1% guideline exceptions?

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